HIREGANGE ACADEMY | AUGUST 2021 |
ACTIVITIES WITHOUT CONSIDERATION –
SUPPLY A MUST FOR GST
APPLICABILITY
CA Madhukar N Hiregange
CA Narendra Nimmala
Traditionally, taxes were applicable only on transactions where consideration /money
was exchanged between supplier and recipient. However, under GST regime provisions
have been introduced wherein activities between related persons or distinct persons
(branch office in other states) are treated to be supplies even if made without
consideration. The provisions of Schedule I of CGST Act, have been downplayed or did
not invite much attention so far. They are expected to be focused in the Audit by
Department which have been few due to the pandemic. While tax is being discharged by
taxpayers in organised sector on supply of goods to related parties including branch
offices, the supply of services needs a much closer look and compliance with the
provisions. 4 years into GST, audits and litigations could be expected to be started by
GST department, who would scrutinize transactions between related parties given the
specific provisions under Schedule I. Some of the IT/ITeS taxpayers are already under
scrutiny for cross border transactions. However, the taxpayers have very little judicial
precedence in these transactions/ provisions. The objective of this article is to
specifically analyze the taxability of the activities carried out between related parties
specifically cross border transactions.
Under Income Tax laws, special provisions have been in existence to curb the avoidance
of taxes on transactions between related parties. With a similar objective, provisions
have been introduced under the GST law as well. Schedule I of CGST Act provides that
supply of goods or services or both between related persons or between distinct
persons when made in the course or furtherance of business would be deemed to be a
supply even if made without consideration.
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One of the pre-conditions for a transaction to be liable to GST even under Schedule I,
would be to qualify to be a ‘supply’ in the first place.
Some of the cross-border transactions which are typically undertaken between related
parties, which may not involve consideration (especially during the initially stages) are
listed below:
of Intellectual
Property Rights (IPR) by parent entity located overseas to
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Indian subsidiaries: Lending of name of Company which maybe a brand in itself or
Permission to use the established brand name
Activities in the nature of quality control
Management services for day-to-day administration commonly known as
stewardship services
Activities provided by parent company in the capacity of shareholder, including
corporate guarantee
Before, we conclude if the above activities qualify to be a supply or not, let us analyze
what qualifies to be a supply. As per section 7 of CGST Act, all forms of supply of goods
or services or both such as sale, transfer, barter, exchange, license, rental, lease or
disposal made or agreed to be made for a consideration by a person in the course or
furtherance of business. Further, the definition of business is very exhaustive to cover
transactions which are one-time activities. A careful reading of the supply definition
would indicate that the activity needs to be in the course or furtherance of supplier’s
business and not the recipient’s business.
Let us now understand the taxability of activities mentioned above:
Provision of Intellectual Property Rights (IPR) by parent entity located overseas to
Indian subsidiaries
In the context of cross border transactions, it is quite common that the subsidiary
company receives IPR, such as, patents, logo, trademarks, etc, in order to provide
services, such as IT/ITeS services, Research & Development, Technical support for
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IT products, back to the parent entity itself. It is pertinent to note that the IPR is
generally made available to the supplier (subsidiary) by the customer (parent
overseas entity) in order to enable the supplier to provide the services back to them.
The activities by the parent entity are not in the course of it’s business but in
subsidiary’s business. Moreover, in most cases there is no commercial exploitation
these IP rights
by subsidiary. They are merely used to provide services back to
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parent entity. In such cases, it would be severe to levy tax on the recipient as import
of services under reverse charge mechanism.
Supreme court in the case of Morgan Staley & Co Inc (Appeal (civil) 2914 of 2007) in
the context of transfer pricing, held that the when the objective of providing certain
activities is to protect the interest of the recipient, then such services do not qualify
for cross charge to the parent entity. The authors believe that similar treatment
could be applicable to GST as well and such activities should not ideally be treated
as supply.
In some cases, the IPR maybe used by recipient for providing services to other
group companies. In such cases, the activities may qualify to be supply of services,
as the services are provided to third parties (although related party), requiring the
Indian recipient to make payment of GST under reverse charge.
Activities in the nature of quality control
Similar to the above activities, the parent company often controls the activities
undertaken by subsidiary in the course of providing services back to parent
company. Parent company performs activities such as giving instructions to
subsidiary, review the activities performed, inspections to ensure quality standards
are met, depute employees to oversee the manufacturing activities, etc. In the case
of Morgan Stanley & Co (Supra), it was held that a customer is entitled to protect its
interest both in terms of confidentiality and in terms of quality control and in such
case, it cannot be said that customer (Parent) has been rendering the services to the
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supplier (subsidiary).
These activities are purely to ensure performance by the subsidiary to the parent
company and should not qualify to be a supply as these activities are not in the
course of business of parent company. These activities are purely to protect it’s
interests in the capacity of customer which would have been undertaken even if the
supplier was a third party and not a related party.
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Management services for day-to-day administration commonly known as stewardship
services
Parent companies located overseas often perform various management activities
for it’s subsidiary company, such as HR activities, accounting, finance,
compliances, legal, budgeting, etc. These are support services provided by overseas
company to it’s subsidiary in India. Unlike the above two activities, these activities
are not for protecting the interest of parent company, in the capacity of customer.
These involve an element of supply and hence may need the Indian recipient to
discharge GST under reverse charge.
Similar arrangement could be seen between domestic group companies, wherein
the concerned resources HR, legal, accounting, etc. are under the payroll of one
company and the support activities are provided to other group companies. Such
arrangements may require a cross charge to be undertaken unless the employees
are under a dual employment of group companies.
Activities provided by parent company in the capacity of shareholder, including
corporate guarantee
Taxability of corporate guarantee has been under litigation even under service tax
regime. The issue is yet to attain finality. However, the ruling under service tax
regime could be of little relevance under GST regime given the specific provisions of
Schedule I.
Some of the other activities performed by parent company in the capacity of share-
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-holder are expenses incurred by parent company for consolidation of books of
accounts, audits, board meeting, expenses for raising funds, etc. While the parent
company may be the indirect beneficiary of the activity given the shareholding in
subsidiary, one cannot lose sight that these activities are performed for the benefit
of subsidiary solely because of ownership interests.
per the OECD
(Organization for Economic Co-operation and Development)
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guidelines, the shareholding activities performed by the parent company would not
qualify as intra-group services and hence would not justify a charge to other group
companies for transfer pricing purposes.
Prima facie, under GST law, corporate guarantee appears to be a supply given the
exhaustive nature of ‘supply’ and ‘business’ definition. However, it is important
that OECD guidelines and the objective behind performing these activities are kept
in mind before concluding the same. Circular 34/8/2018-GST dated 01.03.2018
provides that services provided by Central or State Government to any business
entity including PSUs by way of guaranteeing the loan taken from financial
institutions against consideration shall be taxable. However, the said Circular is not
a comprehensive one and appears to have been issued without detailed
consideration to aspects covered in subsequent paras. It is also important to note
that circulars not in line with the law are non est in law [Ratan Melting & Wire
Industries (2008 (231) E.L.T. 22 (S.C.)]
Above mentioned comments are only preliminary and these aspects need a muchdetailed analysis on a case-to-case basis and the taxability of such transactions is
highly debatable. Some of the aspects which need to be considered before
concluding the taxability would be:
1. Objective of performance of an activity
2. Beneficiary of the activity
3. Whether activity is performed as an obligation
4. Commercial exploitation by the recipient
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5. Would recipient have availed such services from a third party
6. Tax treatment for transfer pricing purposes
Valuation
The valuation of transactions between related parties needs to be as per the CGST rules.
Second proviso to Rule 28 of the CGST Rules provides that where the recipient is
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eligible
to full input
credit of the supply, then the value declared in the invoice shall
be deemed to be the open market value.
In case the Indian subsidiary is eligible for full input tax credit, such companies may
adopt a conservative position and pay the GST on a nominal consideration and claim
ITC of such GST paid in order to avoid litigations. However, if there is an element of
exempt supplies, the taxpayers may have to evaluate the above activities in detail.
The value could be adopted merely for remitting the GST on such services and there is
no requirement to actually make payment of underlying value to the supplier.
However, in case the taxpayer decides to make the payment of underlying
consideration as well and claim expenses for income tax purposes, it is recommended
that the valuation is arrived in consensus with TP provisions in order to avoid
disallowance of expenses for income tax purposes. Alternatively, if costs are known,
cost + 10 % as set out in rule 30 could be adopted.
Conclusion
Given the exhaustive definition of supply and business, some of the activities though
not qualifying to be a supply, Department may litigate the activities performed by
parent companies for their subsidiaries. The provisions of Schedule I are newly
introduced under GST law and therefore the taxpayers have very little knowledge and
precedence on the taxability of such transactions without consideration. It is important
for policy makers to come out with a comprehensive circular, keeping in mind the circ-
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-umstances around which such activities are performed, to aid taxpayers in avoiding
tax disputes on the subject matter. Taxpayers may also want to analyze the above
aspects proactively and document the tax position in order to be well equipped for
scrutiny during regular audits or investigations by Departmental authorities.
CA Madhukar N Hiregange
Feedback: madhukar@hiregange.com | narendra@hiregange.com
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